Let’s say your main objective is to maximize retirement income and you aren’t concerned about leaving a ton of money for the kids. That being the case, you might take out more than you otherwise would, but you still have to be careful not to go through your nest egg too quickly. How do you do that? By using an “investment arc”.
If you studied geometry in school you already know what an arc is. It’s nothing more than a figure that rises and falls like the trajectory of a cannon ball. And this arc can help you make much smarter investments and retirement income decisions. In fact, your retirement accounts are a perfect example of an investment arc.
Look at the illustration below.
This represents the rise and fall of a hypothetical retirement account. It assumes you are 42 when you start contributing to the account. You start off by depositing $4000 each year and grow your annual contributions by 10%. It also assumes that the maximum contribution is $25,000. This example also assumes you earn 5% on your money. Finally, this example assumes you start taking a 4% withdrawal at age 71 and increase your withdrawals by 10% each year thereafter. This does not adhere to the IRS RMD tables but its pretty close. Anyway, it illustrates the point just fine. Have faith.
As you can see, the arc rises at first because you make contributions and because the balance is growing.
During the second phase, you stop adding money because you are retired. But, in this example, you don’t need the money yet so you delay making withdrawals. As a result, the arc continues to climb but at a slower pace.
Once you start making withdrawals the arc begins it’s decent. At first, you withdraw less than the account earns so it continues to grow slowly. But over time, your withdrawals exceed the earnings and the arc starts sloping downwards. If all goes well the money will last well in to your 90s. In this example, the money lasts for 55 years and since this person started funding this account at age 42, she only depletes the account at age 97.
How This Can Help You Increase Your Withdrawals And Not Run Out Of Money
As you can see, this is not only a beautiful mathematical equation; it’s a pretty nifty way to have a financially secure life. But much more than that, this little diagram can transform you into a regular Einstein around money. Here’s why:
1. Time Frame
As I said, this investment has a 55 year life cycle. Does it matter what the value is in any particular year? Not at all. Sadly, some people focus on their account value every year or at least they fret about what the value is on the year they retire. As you can see, that isn’t important. What they should be focusing on are the annual contributions they make and the investments they select during the life of the account. Since we’re talking about long-term, investors who put at least a portion of their money into equity have a much better chance of growing their money faster and thereby increasing their income when they get to the distribution phase.
2. Investment Strategy
From the start, we know this is a 50-year plus investment arc. This investor needs to consider that when she decides how to invest. Her goal should be to grow the account and maximize the safest retirement income. This means she has to compromise and balance her need for growth over the very long term rather than focus on annual stability. Again, the value in any one year is completely irrelevant from a financial standpoint.
This looks really good on paper but if we’re talking about a very long time-frame, a lot can happen and things can go wrong. That’s why it’s important to re-evaluate your withdrawal rate and financial plan on an annual basis. If the market tanks or your needs change, it might be time to adjust your strategy.
My suggestion is for you to print this page out and stick it on your fridge. Send it to everyone you care about. Investors can easily be drawn into reacting emotionally when it comes to money. It might feel good to always keep your money in the bank. I wish I could afford to do it myself. Unfortunately, that is a losing strategy when I consider my long-term goals.
Even though I am an old guy and in my 50’s – I need to think about my investments long-term. Yes, I’ll start taping into our investments at some point. But even when I do, I need that money to continue working a very long time. I have to match the investment arc of that money to my family’s financial needs over our lives.
Does that make sense? Are you considering the investment arc of your money? Why or why not?